China's yuan takes leap toward joining IMF currency basket

WASHINGTON (Reuters) - China’s yuan moved closer to joining other top global currencies in the International Monetary Fund’s benchmark foreign exchange basket on Friday after Fund staff and IMF chief Christine Lagarde gave the move the thumbs up.

Chinese 100 yuan banknotes are seen in this picture illustration taken in Beijing in this July 11, 2013 file photo. Foreign asset managers are preparing to increase their exposure to yuan-denominated bonds, as the International Monetary Fund (IMF) looks likely this month, November 2015, to approve the inclusion of China's "redback" into its currency basket. To match CHINA-YUAN/INTERNATIONALISATION REUTERS/Jason Lee/Files

The recommendation paves the way for the Fund's executive board, which has the final say, to place the yuan CNY=CFXSCNY= on a par with the U.S. dollar .DXY, Japanese yen JPY=, British pound GBP= and euro EUR= at a meeting scheduled for Nov. 30.

Joining the Special Drawing Rights (SDR) basket would be a victory for Beijing, which has campaigned hard for the move, and could increase demand for the yuan among reserve managers as well as marking a symbolic coming of age for the world’s second-largest economy.

Staff had found the yuan, also known as the renminbi (RMB), met the criteria of being “freely usable,” or widely used for international transactions and widely traded in major foreign exchange markets, Lagarde said.

“I support the staff’s findings,” she said in a statement immediately welcomed by China’s central bank, which said it hoped the international community would also back the yuan’s inclusion.

Related Coverage

Staff also gave the green light to Beijing’s efforts to address operational issues identified in a report in July, Lagarde said.

The executive board, which represents the Fund’s 188 members, is seen as unlikely to go against a staff recommendation and countries including France and Britain have already pledged their support for the change. This would take effect in October 2016, during China’s leadership of the Group of 20 bloc of advanced and emerging economies.

China has rolled out a flurry of reforms recently to liberalize its markets and also help the yuan meet the IMF’s checklist, including scrapping a ceiling on deposit rates, issuing three-month Treasury bills weekly and improving the transparency of Chinese data.

Economists said with the yuan’s inclusion in the IMF basket as a reserve currency now looking like a formality, China should step up efforts to build trust between global investors and its policy makers.

China’s heavy-handed intervention to stem a stock market rout over the summer, and an unexpected devaluation of the yuan in August, had raised some doubts about Beijing’s commitment to reforms.

“The PBOC should reduce the frequency of market intervention, allowing market forces to really play a critical role.”

The United States, the Fund’s biggest shareholder, has said it would back the yuan’s inclusion if it met the IMF’s criteria, a U.S. Treasury spokesperson said, adding: “We will review the IMF’s paper in that light.”

If the yuan’s addition wins 70 percent or more of IMF board votes, it will be the first time the number of currencies in the SDR basket - which determines the composition of loans made to countries such as Greece - has been expanded.

“I would say that the likelihood of China’s yuan joining the IMF currency basket this year is very high,” said Hong Kong-based Shen Jianguang, chief economist at Mizuho Securities Asia.

“The only thing that could deter this is if the U.S. led a group rejecting the yuan’s inclusion, which could complicate things. But the United States’ current official stance doesn’t reflect such an attitude,” he said.

Some currency analysts say making the yuan the fifth currency in the basket could eventually lead to global demand for the currency worth more than $500 billion.

But China’s extensive capital controls mean it would take a while before the yuan rivals the dollar’s dominant role in international trade and finance, analysts say.

Its closed capital account still limits foreigners from buying yuan-denominated assets and places caps on how much cash residents can take out of the country. These restrictions, along with concerns that the yuan is set to come under steady depreciation pressure, may cause corporates to back off from holding yuan.

Nonetheless, the People’s Bank of China said the IMF statement was an acknowledgment of the progress China had made in reforms and opening up its economy.

“The inclusion of the RMB in the SDR basket would increase the representativeness and attractiveness of the SDR, and help improve the current international monetary system, which would benefit both China and the rest of the world,” the PBOC said in a statement.

China would respect the board’s decision and continue to deepen economic reforms, the PBOC said.

Additional reporting by Timothy Ahmann in Washington, Jason Subler in Beijing and Brenda Goh in Shanghai; Editing by James Dalgleish & Shri Navaratnam